How to lower oil prices?

By Fester:

Oil is down by about $20 and 15% off from its recent high but it seems to have found support in the mid-$120's range.  John McCain is convinced that oil and fuel price anxiety is his best domestic issue to exploit.  Numerous dumb policies are being proposed by both parties to 'solve' the high prices.  Some blogs are looking at intermediate and long term policy trade-offs.  So how can we lower oil prices and what are the variables that we control?

In the very short run (0 to 4 months) there is not a whole lot we can do to lower oil prices and maintain the semblance of a market economy.  Releasing oil from the Strategic Petroleum Reserve will increase supply on the market but some high cost suppliers may pull some of their oil off the market in response to the drop in prices.  The SPR is limited. It is not credible that it would be completely drained over the next few years to temporarily drop the price of gasoline by a couple of dimes. Since the SPR oil would be perceived as 'windfall' oil, it would not have a significant impact on long run prices.

Instituting a 55 mile an hour speed limit and strictly enforcing it would significantly reduce oil consumption in the United States as most vehicles are aerodynamically and engine-optimized for around that speed.  However getting that law through Congress will take several months.  Arranging a non-combat zone slowdown of training and operations for the US military and also seeking the same with allies may reduce global oil consumption by a percentage point. This may have decent price impacts.  Again, the politics of this proposal would make it extremely difficult to actualize.

If one believes that speculation and hot money has been flowing out of real estate, complex financial instruments and equities AND flowing into commodities, the recent rumblings about restrictions on speculation will slow down the trend of increasing oil prices as the fundamentals of supply and demand catch up. But this will not stop the trend, just slow it down. 

There are two big things that American political leadership can do to lower oil prices before the election.

The first is continuously hope for a mild hurricane season that does not go near Canterall in Mexico, or the central Texas and Louisiana coasts.  Shamans are freely available for consultations on how to actually influence hurricane development.

The second, and this is something that I think we have seen, is to lower the rhetoric, preparation, and perception of tensions and the potential of conflict with Iran.  Higher levels of stability in the Middle East drives down the risk premium attached to each barrel of oil. Even low probability, high cost events can have significant price impacts.  War with Iran is one of those events.  I think we have seen a walk back on the rhetoric and a reduction in the perception of risk of open military conflict with Iran. 

That is about all we can do to realistically lower oil prices in the short term.  In the medium (1 to 3 years), intermediate (3 to 7 years) and long (7 or more years) there are more options available to policy makers. 

Some of them are macro and system changing such as a willingness of a President and Congress to credibly work towards structurally balanced budgets so that short-term deficits run during recessions and slack periods are balanced by short term surpluses during the boom/good years.  This will strengthen the US dollar over the long run as the US will reduce its long run borrowing needs.

Shifting energy demand from hydro-carbons towards non-hydro-carbon based energy sources such as wind, solar, fuel cell and nuclear will also reduce demand and thus prices. One megawatt hour of solar power is not a pure substitute for the equivalent energy of light sweet crude.  Electrical power is seldom generated from petroleum, and electricity is not a common transportation power method.  The substitution would occur as plug-in hybrids become available, and people shift to electrified rail as a transportation system.  The alternative to this alternative would be to embark on the popular but costly and ineffective coal to liquid schemes of turning rocks into liquids and then into fire. 

Changing the federal funding incentives towards equalization of federal policy and subsidies for individual transit and mass transit would be another intermediate to long term solution to reducing per capita demand for petroleum. Some of these changes are small changes.  For instance, equalizing the tax advantages of buying mass transit passes or paying for parking through employer programs would help.  Currently, mass transit users can deduct $115/month while car commuters can write off $220 per month.  Mass transit proposals face much higher cost-benefit hurdles than highway construction.  Mass transit must prove both demand and shorter commutes while highway construction just needs to prove demand.  Equalizing the funding viability criteria would increase the number of mass transit proposals that are funded.  More mass transit builds the network externalities that a good set of systems needs.   

However inaction and letting the market work with some low-end subsidies and assistance may be the best policy solution.  High energy prices are already provoking significant responses to reduce consumption. People are shifting to smaller vehicles, mass transit ridership is up, and the exurbs are not as attractive today as they were a few years ago in the cheap gas era.  Subsidies and supports should be provided for people who are being impacted.  These supports should include expanded LIHEAP heating assistance and potentially a trade-in program/subsidy for old, inefficient cars for small, efficient cars.  But high prices are provoking a response that will undercut super high prices over the intermediate term. 

There is not a whole lot that can be done policy wise over the next couple of years besides not doing a whole lot to make the situation worse.  I just hope the political imperative to "DO SOMETHING" does not make the situation markedly worse than it has to be.